FRANKFURT (MNI) – Any provision of longer-term liquidity for
troubled Eurozone banks suggests that the European Central Bank may once
again provide cover for the shortcomings of national governments.

However, there should be no doubt that this time around the ECB is
in serious exit mode — both regarding ultra-low interest rates and
liquidity support measures.

Irish prime minister Enda Kenny said Friday that his government is
working on a deal with the ECB to finance Irish banks as they
restructure, and he suggested that the central bank may be ready for
concessions for longer-term lending.

The comments come days before the release of Irish bank stress test
results, which are expected to show that the country’s four largest
lenders need an extra E18bln to E25bln in capital, eating up most of the
bank contingency fund contained in the IMF-EU aid package.

According to a report in the Wall Street Journal, citing a central
bank source, a new facility may be introduced to replace the use of
so-called Emergency Liquidity Assistance (ELA), which comes from the
national central bank, not the ECB. “Emergency funding is obviously
critical, but medium-term to longer-term funding would be much more
stable,” Kenny told Irish radio over the weekend.

Irish banks had around E70 billion outstanding in ELA support from
the Irish central bank at the end of February. The certainty of
longer-term funding desired by Ireland would allow banks to shrink
balance sheets more slowly and avoid the additional losses that would
result from “fire sales.”

The timing of the agreement, as well as comments by Kenny, suggest
a potential new facility for Irish banks will be part of the broader
re-negotiations over Ireland’s EU-IMF bailout package, which were taken
off the European leaders’ summit agenda last week because of a deadlock
over Ireland’s corporate tax rates, which other EU countries would like
to see higher.

Finance ministers will resume negotiations after the results of
Irish bank stress tests later this week, European Council President
Herman Van Rompuy said. That is also when news of an alternative ECB
facility is expected to emerge. Kenny spoke of one “package” that “needs
to be adjusted — in terms of the interest rate, and in respect of the
costs of the banking structure that’s associated with it.”

The ECB, which has insisted that it is the job of governments to
recapitalize banks and ensure that they regain market access, will want
to avoid being seen as responding to political pressure or granting
special favors to the Irish government.

According the Wall Street Journal report, access to a special
facility would most likely be linked to strict conditions and firm
commitments to restructuring and recapitalization. The paper also said
that while initially aimed at Irish banks, the ECB would make the
facility open to other Eurozone banks as part of the long-awaited
measure to wean so-called “addicted banks” off of the ECB’s emergency
liquidity operations.

The central bank will likely argue that any potential support is
directed at restoring the Eurozone banking system and thus the
transmission mechanism of the ECB’s monetary policy. The bank might also
note that such a facility will clear the way for the ECB to unwind some
of its non-standard liquidity support, thereby paving the way for a
long-awaited normalization of its regularly scheduled refinancing ops.

How much credibility such arguments carry will largely depend on
the details of any new facility: how high will a potential penalty rate
be? How large the haircuts on collateral? Will rules for eligible
collateral be as lax as those for Irish emergency lending?

And who will stand in should any financial losses be incurred? Will
it be the national central banks — as under the ELA regime — or will
losses be shared across the Eurozone? Would the ECB transfer Irish bank
default risks to the Eurosystem?

There should be no question, however, that the ECB will use broader
support for addicted bank to resume normalization of its liquidity
regime in June, when the current refi schedule expires. An earlier
return to the fixed-rate full allotment method has been postponed for
months by the addicted banks problem.

ECB Executive Board member Juergen Stark said last week that
“credit spreads in corporate bond and money markets have narrowed to a
degree that I would no longer really characterize as disruptive,”
leaving little justification for such unlimited cash injections.

–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com

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